A rule of thumb says if you take your profits in the spring and stay away from stocks for the summer, you’ll come out ahead. Why is that?

From May 2002 through to April 2012, the TSX has been weaker from May to October on six occasions. In the other four years, the pattern wasn’t present, and the market was stronger in the warmer months.

By:Chad Fraser Published on Sun Jul 22 2012

One of the catchier market slogans that pops up every spring is “sell in May and go away,” a rule of thumb that says if you take your profits in the spring and stay away from stocks for the summer, you’ll come out ahead for the year.

It’s one of those catch-alls that can’t be applied blindly, but unlike other market saws, this one may have something to it. This May, the TSX fell 6.6 per cent, posting its worst month of the year. It had regained a portion of that loss, rising 1.8 per cent since June 1, but the TSX is still down slightly on the year.

The U.S. version is known as the Halloween Indicator, which splits the year into two six-month periods, May 1 through to October 31, and November 1 through to April 30. So if you followed this approach and sold all your stocks on May 1, you would then buy them all back on October 31.

So is taking the summer off really a good idea? The U.S.-based Stock Trader’sAlmanac found that if you invested $10,000 in the Dow Jones Industrial Average on November 1, 1950, and got out of the market on April 30, and followed that strategy religiously until 2008, your initial investment would have risen to $474,305. This finding is based on the assumption that you would place the money in fixed-income investments during the summer.

Conversely, if you followed the reverse strategy and invested in the market only from May through October, you would have lost money by October 2008, ending up with just $8,012.

In 2002, researchers Sven Bouman, of Netherlands-based AEGON Asset Management, and Ben Jacobsen of Erasmus University Rotterdam, released a study on the “sell in May” effect. The pair found a similar pattern in 36 of 37 countries, some stretching back centuries. In the U.K., for example, they found evidence of the pattern as early as 1694.

In Canada, you can see it in the performance of the TSX, though it has been more nuanced — at least in the past decade.

During the 10-year span, the TSX rose less than 1 per cent on average from May to October versus more than 6 per cent for the remaining months. That’s a big gap, though it’s important to note that you wouldn’t have lost money by staying invested through the summer.

Many explanations have been put forward over the years, but no one has been able to nail down a single cause. Bouman and Jacobsen found a correlation between lower stock market returns and increased outbound travel, suggesting that summer vacations play a role.

Other theories include the timing of the tax deadline (in Canada, for example, many investors are focused on RRSP investing in the winter months); mutual funds dumping money-losing stocks before their fiscal year’s end; and simple psychology: maybe investors are willing to forgive a company for a weak quarter or two at the beginning of the year, but if results haven’t improved by the six-month mark, many are likely to give up and sell.

All of this may seem like a reasonably strong argument for adopting a sell-in-May strategy, but nobody would advise selling all the stocks you own in the spring and buying them back in the fall. Here’s why:

The slump is impossible to predict. The slump doesn’t always happen. If you had sold in May 2009, for example, you would have missed out on a gain of 18 per cent as the TSX rebounded from its recession lows. Similarly, over the last 10 years, the market put on strong performances in May through to October of 2003 (up 18 per cent), 2004 (up 7 per cent), 2005 (up 11 per cent), and 2007 (up 9 per cent).

You’ll have to pay commissions to both sell all your stocks in May and repurchase them in October.

You’ll miss out on dividend payments, which can provide a significant portion of your portfolio’s overall return.

It would be far better to use the late winter/early spring months to do some spring cleaning on your portfolio, keeping in mind the tendency toward weaker stock-market performance from May to October. This could include cutting back on low-quality or speculative stocks, which tend to fall faster than the market during periods of weakness.

In addition, you could refocus your stock holdings toward companies that are less volatile than the overall market, such as utilities and Canadian bank stocks. The kicker? These stocks tend to pay above-average dividends, so you’ll boost your income stream while you wait out the market lull — should it appear.

Toronto writer Chad Fraser’s work has appeared on The Successful Investor Network and Investing Daily investment websites.

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